For the last two months, Northern Rock has lived in the realms of fantasy finance. It has been playing at being a bank. Yes, it has had a board of directors (albeit with some changes), shareholders and a network of branches. But it has no sustainable business, unless tapping the taxpayer for a regular loan is considered one. Without that Treasury-authorised lifeline of £24bn (and counting), Northern Rock would have long ago run out of the cash to keep trading. Yet the Newcastle-based bank has kept up the charade of being in business, and the government has indulged it.

In his statement yesterday afternoon, the chancellor, Alistair Darling, clung on to the pretence. Northern Rock, he said, was in the process of selling itself off and any bid would only have to be "agreed" by the government. But taxpayers cannot be well-served by allowing the bank to choose which bid to accept. Since Rock shareholders are naturally after the biggest return on their money, they will want to sell it to the highest possible bidder - even if that offer is based on repaying as little as possible to the taxpayer. True, some safeguard comes from the Treasury agreeing to any bid - but, when it comes to this bank, the government has let taxpayers down enough. The ever-mounting loan to the Rock is not disclosed straightforwardly, but buried deep in the Bank of England's balance sheet. Mr Darling has yet to make a clear statement on when this money will be repaid. And yesterday the BBC reported that the Treasury has softened the terms for its credit - on the quiet. This is a very murky way to be handling public funds.

The government's policy on Northern Rock can be summed up in one word: hope. It has hoped a private-sector bidder will offer a reasonable price and guarantee to repay the public loan. The fairytale has had no such happy ending; no generous moneybags has come forward. In the meantime the public loan has grown ever larger. After allowing a few more weeks for talks with bidders, the government will need to get real and consider two other options.

Mr Darling cannot please everyone. Yesterday the chancellor invoked two separate constituencies. "The interest of the taxpayer" is to have his money returned as soon as possible. But "the public interest", as defined by the Treasury, is to preserve confidence in the banking system, and retain as many as possible of the 6,000 or so jobs at Northern Rock. These are respectable aims, but they can not both be met in full. There will have to be a compromise.

So what are the other options? The first is for the government to cut the cord and allow the business to go into liquidation. The taxpayer would have a claim on the assets, so should be repaid. This is an intellectually respectable policy, but it is surely politically unpalatable. It would lead to widespread redundancies and could test the public's fragile confidence in the banking system. Mr Darling would reiterate that Rock deposits had a cast-iron guarantee, but that might not stave off another bank run. In any case, the chancellor would have defeated the purpose of his original intervention: to shore up confidence in British banks.

The alternative is to nationalise Northern Rock. This would not be like previous nationalisations: the government would not enter the banking business, but rather take control of a situation which is in a downward spiral. Treasury officials could wind down the bank in an orderly fashion, or sell it off on terms as favourable as possible both to taxpayer and workers. This would be a painful process, and there would still be redundancies. At least this wouldn't be the smash-and-grab raid that typically accompanies a liquidation. It is understandable that ministers did not consider this option at the outset, but the situation has now deteriorated too far for them not to put it on the table. Of an unappetising range of options, nationalisation is surely the least distasteful.